Thousands of families may face increased inheritance tax bills in the coming year, as potential government proposals and existing changes to pension tax calculations are set to broaden the tax net. Experts are advising individuals to assess their assets and plan proactively to mitigate potential tax liabilities.

Upcoming Pension Taxation Changes

Starting in April, pensions will be included in estate valuations for tax purposes. This change means that estates previously exempt from inheritance tax could now be liable. For individuals aged over 75 at the time of death, beneficiaries may face a significant tax burden. Depending on their income tax rate, beneficiaries could face a combined tax rate of up to 64% on inherited pension funds, accounting for both inheritance tax and income tax on withdrawals.

Potential New Estate Tax

Further changes could be on the horizon if proposed plans for a new estate tax are implemented. This potential tax, rumored to be around 10% on all estates, is being considered to help fund social care services. While it remains unclear if this would replace or supplement the current inheritance tax, experts suggest it is unlikely to reduce the overall tax take on wealth. The cost of adult social care in England alone significantly exceeds the current inheritance tax revenue, indicating a potential need for increased taxation to cover expenses.

Understanding Inheritance Tax Thresholds

Currently, individuals can pass on up to £325,000 tax-free, known as the nil-rate band. For married couples, this threshold doubles to £650,000. An additional allowance, the residence nil-rate band, increases the tax-free threshold for passing on a home to direct descendants. This allowance raises the individual threshold to £500,000 and to £1 million for couples. To determine if an estate might exceed these thresholds, individuals should calculate the total value of their assets, including property, savings, and investments, with the inclusion of pensions from April.

Strategies for Inheritance Tax Planning

Experts recommend several steps for individuals concerned about inheritance tax:

Financial Assessment and Gifting

It is crucial to first determine if inheritance tax is likely to be a concern. If so, individuals should assess how much wealth they can afford to gift away. Gifts made seven years prior to death are generally exempt from inheritance tax. However, individuals must ensure they retain sufficient funds for their own future needs, including potential long-term care costs. Cash-flow modeling can assist in forecasting future financial requirements and identifying amounts that can be safely gifted.

Wills and Beneficiary Designations

Reviewing or creating a will is a fundamental step for everyone, regardless of inheritance tax concerns, to ensure assets are distributed according to one's wishes. For couples, leaving assets to a spouse or civil partner is tax-free, while gifts to others are subject to tax. Updating nominations for pension death benefits is also critical, especially given the upcoming changes to pension taxation.

Planning for Tax Payment

Executors typically have six months from the death of an individual to pay inheritance tax. The tax must be paid before probate is granted. If the bill is paid late, interest is charged. To avoid potential liquidity issues, individuals can consider life assurance policies placed in trust. The payout from such a policy can be used by beneficiaries to cover the inheritance tax bill without needing to access the estate's assets immediately.

Other Planning Tools

Other strategies include putting life assurance policies into trust to keep them outside the estate for tax purposes. Deeds of variation can be used within two years of a death to redirect inheritance to the next generation, potentially avoiding a second layer of inheritance tax. For those with significant assets, specialist investments offering Business Property Relief may provide inheritance tax advantages, though these are often higher-risk.

Experts emphasize that early and professional advice is essential for navigating the complexities of inheritance tax planning and ensuring personal financial security is not compromised.